It Wasn't Lax Lending Standards. Really.

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THE STASH NOVEMBER 9, 2009

It Wasn't Lax Lending Standards. Really.

Here's some more evidence against the declining lending standards theory of the crisis -- and support for the claim that it was the design itself, or existence, of subprime mortgages that played a seminal role in our housing woes.

In a new working paper, Dean Corbae and Erwan Quintin investigate the impact of the financial innovation that was the subprime mortgage. Maybe more importantly, they try to figure out any social benefit that may have been created by the ability to  make lower down payments -- the key innovation that subprime made widely available.

Corbae and Quintin report that we'd have about 50% fewer foreclosures had subprime mortgages not been made available:

In our simulations, when mortgages with low initial payments do not become available before the price collapse, the increase in foreclosure rates are 50% lower on impact and 25% lower at the peak of the crisis than our experiment where LIP [low initial payment] mortgages are available.

The reason for this, as has been pointed out more than once, is that subprime loans were very sensitive to home prices.

Ironically (and maybe tragically), Corbae and Quintin also report that people most likely to benefit from the introduction of subprime were ones with higher incomes:

Somewhat surprisingly at first glance, agents born with low income prospects benefit the least from mortgage innovation. The reason for this is that in all likelihood they will remain renters their entire life. The gains are so small, in fact, that in a model where house prices respond to demand for housing, mortgage innovation is likely to have a negative impact on agents who are born poor. Mortgage innovation primarily benefits the agents who are at the margin between renting and owning or need some financial help to buy bigger houses.

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posted in: the stash, economy, social issues, dean corbae, erwan quintin

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